Why Bad News Is Good News in Europe – 7 Charts Showing What You Really Need to Know by Frank Holmes

There’s little denying that the U.S. economy is on the upswing since the recession. Manufacturing is strong, jobless claims are falling and wages are rising. Delta Air Lines, which we own in our Holmes Macro Trends Fund (MEGAX), recently announced that it will be giving its 80,000 employees $1.1 billion in profit sharing, while Wal-Mart, held in our All American Equity Fund (GBTFX), unveiled plans to hike its minimum wage to $9 an hour in April.

Indeed, things are shaping up here in the U.S., but unfortunately this has not been the case in Europe. From Greek drama to Russian aggression, bad news seems to be the order of the day.

Until now.

Because of central banks’ monetary easing, weakening currencies and low fuel costs—courtesy of the American fracking boom—Europe is finally showing signs that it’s ready to turn the corner and set a path toward lasting economic recovery.

1. Emerging Europe PMIs Swinging Up

The Purchasing Managers’ Index (PMI), as I’ve often said, is a highly effective tool that we use to forecast manufacturing activity six months out. Any reading above 50 indicates growth in manufacturing; anything below, contraction. This allows us to manage our expectations and get a good sense of where to position our funds.

As you can see, the European Union (EU) as a whole has recently improved, but emerging countries such as the Czech Republic, Poland and Hungary are posting very solid numbers in the mid-50s range. Much of this is due to low fuel costs and weaker currencies, which make exports more attractive.

Europe
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2. Growth in the Eurozone Is Good for the Globe

Our investment team’s research has shown that when the one-month reading for the global PMI crossed below the three-month moving average, there was a significant probability that materials, energy and commodities would fall six months later. Conversely, when it crossed above, manufacturing activity would ramp up, which greatly improved the performance of commodities such as copper and crude oil, not to mention the materials and energy sectors.

Europe
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It’s very welcome news, then, to see growth in the eurozone, since its PMI readings are factored into the global score. Today we learned that the preliminary Flash Eurozone PMI advanced to 53.5 for the month of February. This is huge. Not only is it a seven-month high for the eurozone, but it’s also nearly in line with the U.S. reading, which came in at 54.3. Even France—a perennial and disappointing laggard in manufacturing—posted its best results in three-and-a-half years.

3. Surprise! Europe Is Beating Expectations

The Citi Economic Surprise Index, simply put, tells you if a country or region’s economic news is beating—or, conversely, falling below—analysts’ expectations. The higher the number, the more it indicates that economic data is exceeding forecasts.

Europe
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You can see above where the eurozone has surprised consensus. For most of 2014, the region was in a declining trend, whereas the U.S. was headed higher. More recently, though, we’ve seen a huge advancement in Europe, despite negative news coming out of areas such as Greece—which today managed to strike a deal with its euro-partners to extend the Mediterranean country’s bailout program by four months.

4. GDP Growing

If you look at Europe’s GDP as a whole, it’s expected to grow slightly over 1 percent in 2015. But the GDP in Eastern European countries such as the Czech Republic, Romania, Poland and Hungary is expected to grow double that or more.

Europe
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These countries are benefiting from the broad recovery, for sure, but they also have their own dynamics. As emerging markets, they have more room to run and grow.

5. No Lack of Confidence in Consumption

Another sign that the European recovery is underway is the recent uptick in spending habits. Not only does the consumer confidence index (CCI) for the eurozone far exceed its long-term average, but it’s also at its highest reading since soon before the financial crisis.

Europe
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6. Russia, the Not-So-Bad News Bear?

Nearly every day we’re reminded of Russia’s political and financial troubles, but the worst is likely behind us. It appears as if Russia’s market and currency, the ruble, bottomed in mid-December. This is also the first time since the summer that the MICEX Index crossed above its 50-day moving average, breaking through resistance.

Europe
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The situation in Ukraine is not pretty, but global investors understand it and are getting comfortable putting their money in Russia again because it’s inexpensive. The bad news has been priced in, and it looks as if the market is willing to move higher.

Russian credit default swaps (CDS) are also looking better. CDSs allow sellers to assume and buyers to reduce default risk on a bond. The swap spreads improved in February, indicating the market is looking past current events such as international sanctions and the ceasefire in Ukraine and seeing Russia’s risk declining in the future.

7. Low Valuations, High Dividend Yields

Emerging European equities, like Russian stocks, are trading at a big discount relative to those in U.S. and Western European markets.

Emerging Europe Cheap Relative to Developed Markets
Country Index P/E Ratio Dividend Yield
Western Europe Stoxx 600 23.6 3.6%
United States S&P 500 Index 18.4 2.0%
Poland WIG 20 15.5 3.9%
Romania Bucharest BET Index 9.9 3.6%
Turkey BIST 100 Index 9.6 1.8%
Russia MICEX Index 9.0 4.1%

Many of the emerging European countries are currently trading at less than 10 times. Therefore, you get that winning combination of low valuation and high dividend yield.

We’re definitely starting to see the early signs that Europe is reflating its economy. Attractive PMI data, positive economic surprises and growing consumer confidence all point to a strong recovery, one that should bode well for global investors in general and our Emerging Europe Fund (EUROX) specifically.

In case you missed this week’s webcast on this very topic, you can still listen to the replay on demand and download the slideshow.

Index Summary

  • The major market indices finished higher this week.  The Dow Jones Industrial Average rose 0.67 percent. The S&P 500 Stock Index advanced 0.63 percent, while the Nasdaq Composite moved higher by 1.27 percent. The Russell 2000 small capitalization index rose 0.71 percent this week.
  • The Hang Seng Composite rose 0.61 percent; Taiwan was closed this week and the KOSPI advanced 0.20 percent.
  • The 10-year Treasury bond yield rose 6 basis points to 2.11 percent.

Domestic Equity Market

The S&P 500 hit another new high this week as the markets embraced the de-escalation of political events in Greece, better economic data out of Europe and dovish comments from the Federal Reserve. Sector returns were generally positive except for energy and telecommunications. Cyclical areas of the market have been stronger recently and that theme continued this week.

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Strengths